Groove Mobile Acquired by NMS for 45 Cents on the Dollar; Company Never Found Its Groove

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One of the Boston area’s oldest mobile content companies has unexpectedly exited the scene. After raising $6 million in new venture funding as recently as last August, Bedford, MA-based mobile music distributor Groove Mobile will be acquired by Framingham, MA-based NMS Communications (NASDAQ: NMSS) for a reported $14.5 million. That’s a yield of about 45 cents on the dollar, when the acquisition price is set against the $32 million the startup raised over at least four funding rounds since 2001.

According to an announcement issued by NMS late yesterday, Groove will become part of LiveWire Mobile, an NMS subsidiary formed in December to manage mobile storefronts where cellular carriers sell music and video downloads, ringtones, and ringback tones. Groove’s only U.S. customer is Sprint, but the company works with 11 other mobile operators in Europe and Canada, with an aggregate subscriber base three times the size of LiveWire’s existing market.

The acquisition solidifies LiveWire’s identity as a mobile services provider separate from NMS, which has been working to establish the two businesses as distinct entities; the non-LiveWire part of NMS sells software platforms used by communications equipment makers to handle voice, video, and data applications such as voice mail and interactive voice response systems. “Over the past year, we have taken a series of steps to more clearly delineate and enhance the value of each of our LiveWire Mobile and NMS Communications businesses,” NMS chairman and CEO Bob Schechter said in last night’s announcement. “With the acquisition of Groove Mobile, LiveWire Mobile gains significant new customers, enhances its value proposition to operators and improves its financial profile.”

But Groove’s absorption by LiveWire at a fire-sale price probably isn’t the kind of ending that company employees and investors were looking for. Groove Mobile was launched in 2001 under the name Chaoticom, with backing from the eCoast Angel Network and Waltham, MA-based Kodiak Venture Partners. (The amount of the investment wasn’t revealed, but reasoning backward from the total invested and the amounts of subsequent funding rounds, it must have been about $8.5 million.) Chaoticom was the first spin-out company in the history of the University of New Hampshire in Durham, NH, and its name reflected a breakthrough in chaos theory by UNH mathematics professor Kevin Short. The technique invented by Short, called chaotic compression technology (CCT), could be used to compress a 4-megabyte audio file to 600 kilobytes while simultaneously encrypting the data. The company applied the work to downloading music over cellular data networks, where bandwidth is at a premium.

At the time, CCT evoked great optimism. “The upscale potential of Professor Short’s technology is tremendous,” said George McQuilken of the eCoast Angel Network in a UNH press release about the company’s launch. “If we can extend Kevin’s research, and prove it in practice, Chaoticom could become a major force in the networking and communications field.” McQuilken said he hoped to raise $25 million and take the company public by mid-2003.

An IPO wasn’t in the cards, but in 2003 the company did procure a major second-round investment—$9 million from Cambridge, MA-based Charles River Ventures. In 2005, Chaoticom changed its name to Groove Mobile, and the following year it raised another $8.5 million in a round led by Egan-Managed Capital, with participation by Charles River, Kodiak, and Star Ventures. A final $6 million investment came in August 2007, from Texas-based Orix Venture Finance.

Meanwhile, the company’s music service gained traction in Canada and overseas; Groove signed deals to enable full-track song downloads for subscribers of Orange, Vodafone, MTS Allstream, and The 3 Group, Telecom New Zealand, and Canada’s Bell Mobility. It also developed an extensive network of music-industry partners, including EMI, Warner Music, Sony BMG, Universal Music Group, Beggar’s, the Digital Rights Agency, and The Orchard, ultimately accumulating a catalog of some 1.5 million songs.

But the company’s foothold in the United States was limited to Sprint, the country’s third-largest carrier after Verizon and Cingular (now AT&T). And despite innovative features such as “Tell-a-Friend,” its secure peer-to-peer music sharing system, Groove faced mounting challenges from competing music download services such as Verizon’s V Cast and Apple’s iTunes.

NMS said Groove generated over $7.5 million in revenue in 2007. But that accounts for only a tiny fraction of the overall market for mobile-device song downloads; between April 2007 and January 2008 alone, iTunes customers bought more than 1.5 billion songs for their iPods and iPhones, at $0.99 per song. (Groove downloads cost $2.50 per song.)

Ultimately, the failure of Groove’s original compression technique to open up a huge market in mobile-phone music downloads seems to be the result not of any technological shortcomings but of cellular subscribers’ unwillingness to use their phones as their primary music devices. Downloads at Groove and other mobile-music services have always lagged far behind those at iTunes, and until the advent of the iPhone last year, no company had really figured out how to successfully combine a cell phone and a music player. Ringtones and ringback tones have proven to be more popular than full-track downloads on cell phones, and this may wind up being LiveWire’s focus; as NMS noted in its announcements, ringback tones alone are expected to be a $2.9 billion business worldwide in 2008.

As part of the NMS acquisition, Groove’s investors will be required to retire all of the company’s outstanding debt, so there’s a big write-off coming for Charles River, Kodiak, and the company’s other venture funders. NMS said that Groove and LiveWire Mobile will consolidate office locations and that “most” of Groove’s employees will be offered jobs at LiveWire.

I called Charles River Ventures, Groove’s single largest venture backer, for comment on the disappointing exit. I was told that the partner who originally directed the Groove Mobile investment is no longer with CRV, and that no one else was available to speak with me.